Financial Analysis 101-155 Ratio Analysis Part 2

In this segment,
we'll look at how you will obtain the
financial ratios, as well as the liquidity
and activity ratios. We are getting our
ratios from Reuters.com. So, first go to www.reuters.com. From there, select markets
and then scroll down and select stocks. Now we enter the company
name or ticker symbol. For example, Apple is AAPL. And I hit search. Reuters wants to
show the exchange so AAPL.O is telling us that
it's on the NASDAQ exchange. So I will select that.

And we go to the
overview page for Apple. A few of the ratios are
contained on the overview page. We can see that Apple is at $490
today and the price changes. It is up $1.32. A little bit of
a roller coaster. A few of the ratios are
found on the overview page. We have the price earnings
ratio and earnings per share here, as
well as dividend, dollar amount, and
dividend yield. When you see a ratio
with TTM after it, that means it is calculated
using the trailing 12 months, or the last 12 months. Now back up to the menu bar. Select financials. Under the financials
tab, we get the ratios. We don't really get the balance
sheet or income statement. At the top of the page we
will see some historical data on revenue and
earnings, estimates of what analysts think future
sales and earnings will be, and finally we get
down to our ratios. Valuation ratios are what
we call market ratios. And you see the company
and the industry there. We'll be using both. Then we have dividend ratios,
growth rates, and finally what they call financial
strength ratios, we call the first
couple liquidity ratios and then the next several
are leverage ratios.

We're going to start
looking at individual ratios by looking at the current ratio. The current ratio is
calculated using MRQ. When you see MRQ that means
the most recent quarter. So it is not a
measure of 12 months, it's just the last quarter. These ratios are as up
to date as they can be. They're using the latest
financial information available. That's why we're
looking at them, too, not going all the way back
to the last annual report for everything.

Liquidity ratios
answer the question, can the company
meet its obligations over the short term? I.e., is there enough
cash to pay the bills? And it measures how many
dollars of short term assets are available for every
dollar of short term liabilities owned. And it's simply calculated
by taking current assets and dividing by
current liabilities. Generally, the higher the
ratio, the more the liquidity. Microsoft, for example, has
a current ratio of 2.71. This means that for every
dollar in current liabilities, Microsoft has $2.71 in current
assets to pay those bills. Apple, on the other hand,
has a ratio of 1.88. So we would say Microsoft
is more liquid than Apple. Here's a couple that
are little more extreme. Walmart has a liquidity
ratio of 0.83. This means that for every
dollar in current liabilities, Walmart only has $0.83
in current assets. Will Walmart be able
to pay its bills? Well, it is Walmart. Yes, it well. And this is because Walmart pays
its vendors slowly and is very, very efficient in cash
and asset management.

Fastenal, on the other hand,
has a liquidity ratio a 5.95, almost six. So that means for
every current liability that they have– every dollar
in current liabilities– they have $6, almost,
in current assets. Why? Well, Fastenal is a very
conservative company and always has a lot of cash. Is it better to have a very,
very high current ratio? Well, not necessarily. Cash does not
generate much income. You don't earn much
interest on cash these days, but it does provide safety. Who uses these ratios? A very important set
of users is vendors. Vendors will look at
the financial statements of a company to see if they
believe the company will be able to pay them on time if
they get the company credit. This is one of the most
commonly used ratios. Another liquidity ratio
is the quick ratio. Answers the same
question, but it looks at what they
call quick assets. In the quick ratio,
we subtract inventory, because it is not as quick to
turn inventory into cash as it is to turn accounts
receivable– typically 30 days– cash and investments into
cash to pay liabilities. So sometimes this shows
a different story.

Again, Microsoft,
more liquid according to this measure than Apple. Look at Walmart. For every dollar in
current liabilities, they only have $0.24
in quick assets. Very low. Fastenal, still,
for every dollar in current liabilities,
$2.88 in quick assets. Very strong in liquidity. Again, used by vendors
who want to know if they will be paid on time. Also used by management
to help them determine, do they have enough liquidity
or not enough liquidity. A second type of ratios is
what is called asset management or activity ratios. These are more what I think
of as a measure of speed. For example, the accounts
receivable turnover measures how quickly is the
company collecting or turning over its accounts receivable. The turnover is calculated
by dividing annual sales by the accounts receivable. And the number of days
sales in receivable is measured by taking
365 days in the year and dividing by the
receivables turnover that you just calculated. For example, Microsoft's
accounts receivable turnover is 4.68 times per year. This means that they have 78
days in accounts receivable. Is this good or bad? Well, this can depend
on the industry. But for example, if the terms
that they gave their customers were 30 days– in other
words, their customers are supposed to pay in 30 days–
78 days would be very bad.

What we can say is that
Apple, with a turnover of 20 and only 18 days in receivables,
has a faster– and therefore better– accounts receivable
turnover than Microsoft. Who uses this ratio? This ratio is very commonly
used by management. It can help determine
whether they're being paid on time according
to their credit terms, whether there is trouble–
they need to go out and really work on collecting
accounts– and it can be used to evaluate the
performance of the accounts receivable department or
accounts receivable management.

Another activity ratio is
the inventory turnover. How quickly is the
company selling, or turning, its inventory? I think of grocers. When you have fresh
produce you expect them to turn over that
inventory every few days. This ratio will vary
widely by industry. Calculated similar to the
accounts receivable turnover. Microsoft has a
turnover of 13 times. They have 28 days sales and
inventory, measured in days– and it's always whole days. We don't have, like, 28.2 days.

We round it up to
the nearest day. Apple, on the other
hand, has a turnover of 74 times per year,
which means they only have five days
sales and inventory. Now Microsoft, what do they
have in inventory, software and maybe tablets? Apple, you would think
would have more inventory, but they have been very
efficient in having the people that are
manufacturing products for them and their dealers
hold the inventory. So they have very little
invested in inventory at any time. The faster the better, so
the higher ratio, the better. And again, this is
used by management to manage performance and
monitor activity and trouble spots. One really key
ratio for a company that will impact the total
performance of the company is the total asset turnover.

It answers the question,
how efficiently is the company using its assets
to generate sales overall? So for the turnover,
we take the total sales divided by total assets. The higher the ratio,
the better or faster. The lower the ratio, the
slower the turn, or worse. For example, Microsoft
at September 30 had a total asset
turnover or TAT, of 0.59. Apple, on the other hand,
had a turnover of 0.93, so that is better. That's almost one. What this means is that for
every dollar in total assets, Apple generated $0.93 in sales. Again, this is a very key ratio. And it is use pretty
much by everyone who is evaluating the company. In the next segment we'll take
a look at profitability ratios..

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